Back to earth for Rio Tinto earnings as commodity prices fall while costs soar. Regardless, RIO has a high quality portfolio albeit skewed to iron ore and Chinese steel production.
Result. Underlying EBITDA of US$27.1bn was in-line with the market. Underlying net earnings of US$12.4bn was -41% down on the prior year mainly due to lower commodity prices and higher costs. RIO reported free cash flow of US$9bn which funded capex of US$6.8bn and full year dividends of US$8bn. Net debt at 31 December was US$4.2bn.
Commodity prices. As usual, commodity prices dominated the outcome of RIO’s operating earnings. In Iron Ore, the largest division by earnings, the average realised price fell 26% subtracting US$8.8bn from earnings. A -4.5% fall in the copper price lopped US$658m from that division’s earnings. In contrast, the aluminium price increased by almost 15% adding US$787m to divisional earnings although this was more than undone by ~US$1.9bn of higher costs. Context is still important, and it should be recognised that FY21 commodity prices were exceptionally high.
The outlook for commodity prices remains positive. Global aluminium inventories are very low creating upward pressure. Copper demand is resilient as EV manufacturers and decarbonisation projects soak up soft traditional copper demand. China’s 2022 iron ore imports were unchanged over the year and its crude steel production was also flat. But that occurred during a hugely disrupted period of COVID-19 restrictions which are now receding. The iron ore price has been steadily improving as a consequence.
Inflation and costs. Higher producer price inflation (PPI) together with persistently high costs (energy, diesel, raw materials) subtracted ~US$4.5bn from RIO’s FY22 EBITDA. PPI in Australia began the yar at 5.5% and exited at 16.4% while US and Canadian outcomes were not much better. In Aluminium refining, for example, caustic soda accounts for 23% of costs and the price more than doubled through the year. Diesel prices in the Pilbara iron ore operations averaged $0.88/l compared to $0.49/l in the prior year.
Divisions. Iron Ore remains by far the largest division reporting EBITDA of US$18.6bn down -33% on last year. The Simandou project in Guinea is advancing at snail’s pace, but the Rhodes Ridge project in WA (RIO 50%) could underpin RIO’s competitive position in the Pilbara for decades if it comes to fruition (6.7bn tonnes of resource). Shipments for 2023 will be 320-335mt subject to the usual factors of weather and operational efficiency.
Copper is at an interesting juncture now that RIO has tidied up its ownership stake and got the Mongolian Government more onside. RIO thinks this project could reach 500ktpa of copper production by around 2030 (with ~330kozpa gold) if everything goes to plan. RIO has spent US$15bn in Mongolia since 2010.
Aluminium faced a big margin squeeze in 2H22 as input prices soared. Long term the energy equation remains central to profitability but demand for aluminium is linked to the decarbonisation theme ensuring the most efficient producers will do well. RIO has a solid position from bauxite right through to refined aluminium and its geographic spread is also noteworthy.
Investment View
RIO’s themes of future commodity demand echo those of BHP. RIO sees the global energy transition together with growth in traditional demand as supportive of its core commodity businesses. In fact, RIO has an ambition to double its annual copper output by the end of the decade through brownfield and greenfield projects. Its stakes in Escondida (30%) and Oyu Tolgoi (100%) are two of the largest copper projects in the world and it has options in others.
In many ways, this was a repeat of the interim result with all the same factors at play.
Despite the pullback in the dividend (payout ratio unchanged at 60%), RIO is fairly valued at around 5.5x EV/EBITDA and a PER of ~11x. The dividend yield of ~5% is above the ASX200 yield.
Risks to Investment View
RIO’s reliance on China as a major ‘customer’ may be an issue of concern. Geopolitical tensions have spilled over in eastern Europe and the same could easily occur between China and Taiwan. We do not know how RIO would be affected if this happened, but it would clearly be material to earnings. We note that Chinese company Shining Prospect is a major shareholder in RIO with 10.3%.
Recommendation
We have retained our Hold recommendation.
Figure 1: RIO FY22 EBITDA FACTORS
Figure 2: RIO IRON ORE
Figure 3: RIO IRON ORE EBITDA FACTORS
Figure 4: RIO DIVISIONAL EBITDA
Figure 5: EBITDA SENSITIVITIES
